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Mexico Exchange Rate December 2016

Mexico: Three scenarios for Mexico after the Trump administration takes power

December 2, 2016

The 31 August meeting between Mexican President Enrique Peña Nieto and Republican nominee Donald Trump marked the beginning of what many analysts consider to be a difficult bilateral relationship. Although neither put all his cards on the table in their first meeting, it was clear that the two most unpopular men in Mexico started off on the wrong foot and that their relationship as leaders will develop under the conditions imposed by the Republican magnate. The meeting in late August is more relevant than ever now that Trump is set to take office in January, a reality that has ignited fears across Mexico where citizens closely monitored the U.S. electoral process.

No country in the world is as uneasy as Mexico about its future following Trump’s victory. His anti-Latino and anti-free-trade rhetoric have been directed toward the two most important issues in the U.S.-Mexico relationship: immigration and the North American Free Trade Agreement (NAFTA). Should Trump’s most radical proposals related to immigration and trade be implemented—Republican control of both Houses of Congress will provide him with scope for action—the prospects for Mexico’s economy will be grim.

The Mexican peso—the market’s favored proxy for U.S. election risk—weakened sharply after Trump’s victory was announced, trading at a rate weaker than 20.0 MXN per USD for the first time in history. The plunge largely followed investor sentiment related to the “Trump shock” as well as domestic sentiment driven by sluggish economic growth, a deteriorating outlook and the Mexican government’s weak approval rating by both consumers and businesses. Although, the Central Bank responded with an interest rate hike to stem the fall of the peso in the aftermath of the election, the Finance Ministry stated that no immediate fiscal measures will be taken, though it did vow to make necessary adjustments in order to prevent serious financial turmoil.

As the dust is settling following the election, the Mexican currency has been trading at around 20.5 MXN per USD. Some appreciation is still likely due to higher domestic interest rates, a recovery in oil prices and a narrower current account deficit, but prolonged U.S. policy uncertainty and prospects of an interest rate increase by the Fed in December could keep the peso from strengthening. Analysts project that the peso will continue to face some volatility in the weeks ahead of the upcoming Fed meeting in December. They expect the peso to end the year at 20.85 MXN per USD and see uncertainty weighing on next year’s outlook. The Consensus view among forecasters is that the peso will weaken further and end the year at 21.11 MXN per USD.

The Mexican government has recognized that it does not have a contingency plan for a Trump victory. This has resulted in considerable uncertainty regarding the future of policy between the two countries. Therefore, there are three scenarios to consider for the coming years and beyond, along with the outcome of each.

Under the most benign scenario for Mexico, Trump would take a broadly pro-business and pragmatic approach. While not making too much effort to strengthen the existing economic ties between the two countries, he would also not sabotage them. Such an outcome would likely stem from the realization that U.S. businesses would also stand to lose significantly from a trade war with Mexico and that the consequences of protectionism come at a political cost. Under this scenario Mexico would not fare much differently than within the majority of our analysts’ baseline scenario: weak but steady growth in 2017 and 2018.

A scenario with a substantial impact and a significant risk to the outlook is one in which Trump pursues his most radical agenda towards Mexico, leveraging Republican control of both Houses of Congress. Although there are institutional checks and balances in place that would regulate Trump’s ability to fully implement his agenda, the robust executive powers of the presidency, coupled with control of Congress, suggest that Trump would enjoy few constraints, at least in the first two years of his term. Under this scenario, the worst impact on Mexico would be due to the renegotiation of NAFTA or the implementation of U.S. protectionist trade measures. NAFTA has effective dispute-resolution mechanisms and allows for retaliatory actions. However, a resulting trade war would damage both economies, though Mexico would be hit harder, given its greater dependence on the U.S., which buys 80% of its exports. Other damaging measures could be the implementation of capital controls on remittances as well as mass deportations of illegal Mexican immigrants that could put the Mexican labor market under pressure. Some of our analysts consider this scenario to be the likely, and if it comes to fruition, Mexico will see its economic outlook deteriorating drastically with economic growth in the medium term falling below 2.0%. Moreover, there is a significant risk that the economy could enter into a mild recession and that the peso could weaken further, should protectionism be fervent.

The worst-case scenario is if Trump were to proceed with a severe protectionist agenda, which in turn would have a strong impact on Mexico’s economic growth, including a recession at some point in the coming two years, and would be complemented with a coercive attitude toward the Mexican government in order to boost President Trump’s popularity at home. Against this backdrop, Mexico would have few tools to counter this, given the huge power gap between the two countries along with Mexico’s hefty dependence on the U.S. in terms of defense and military intelligence aid in the war against drug cartels. In this scenario, should the U.S. demand that Mexico pay for the border wall, it is highly possible that Mexico would do so. The U.S. could also use other means to exert coercive influence upon Mexico aside from a threat of military action—which, although unlikely, was hinted at during Trump’s campaign. Such actions could include leveraging the vast amount of intelligence that is in the hands of U.S. intelligence services on Mexico’s drugs cartels and on other criminal activities such as money laundering and corruption, which could put the current Mexican government in a compromising position. The administration could either then concede to Trump’s demands or risk more scandals being revealed at a time when Mexicans rank corruption, along with insecurity, at the top of their list of concerns. Consequently, this scenario carries with it the significant risk of prompting political instability in Mexico, especially in light of the government’s poor accountability and feeble handling of previous political crises, and would come at a time of important political changes in Latin America.

Bottom line: Mexico's economic and political fate hang in the balance

Donald Trump being elected as the next president of the United States has been frustrating enough for Mexico, yet the most frustrating aspect is that the U.S. neighbor to the south has minimal leverage to mitigate the impact of Trump’s policies. Mexico’s economic (and perhaps political) fate for the next four years rests entirely upon Trump’s willingness to move forward with the full agenda that he promised during his campaign, particularly in the next two years when both Houses of Congress will be under Republican control. Although the economic impacts will be felt first, a political fallout in Mexico caused by Trump’s presidency should not be underestimated, and this could have more damaging and long-lasting consequences for the country’s outlook.

Sentiment among Mexican consumers rose in August, reaching an over one-year high and extending the streak of consecutive improvements in consumer confidence seen since Donald Trump’s inauguration in January 2017, when sentiment had slumped to a record low.

The seasonally-adjusted manufacturing indicator produced by the Mexican Institute of Financial Executives (IMEF) leaped from 51.8 in July to 54.0 in August, marking the second-best reading in nearly three years.